How to Trade Bonds

Even if you don’t consider yourself an investor, you’ve probably heard of bonds. Bonds are a relatively simple product to trade. Casual investors, and even those who don’t trade any other product, can buy bonds using a brokerage like Interactive Brokers.

If you’re interested in the bond market, check out Benzinga’s guide and learn the ins and outs of how to trade bonds and use this activity to make the most of your investment portfolio.

What is a Bond?

A bond is a debt security issued by corporations and governments to raise funds. It is like borrowing money from someone, but instead of lending cash directly, the borrower issues a bond that obligates them to pay back the loan amount plus interest at a specified date in the future. Bonds are typically issued with maturities of more than one year. Interest payments on bonds are usually paid twice per year (semi-annually) until the bond matures.

Types of Bonds to Trade

Four main types of bonds are available. Here's a quick rundown of each.

1. Treasury

These bonds are the highest-quality securities issued by the U.S. Department of the Treasury. Treasury bonds, also known as Treasury bills, have a maturity date that can range anywhere from 10 to 30 years. Once your bond reaches maturity, it will stop earning interest, and the principal investment will be repaid to you. You don’t need to pay taxes on the interest, and there is little risk of default because Treasury bonds are backed by the U.S. government.

2. Sovereign Bonds

Sovereign bonds are also issued by the federal government. The difference is that these bonds can be denominated in the U.S. dollar or in global reserve currencies. National governments use sovereign bonds to finance government spending programs. The types of sovereign bonds you may encounter include agency bonds and savings bonds. Risks of sovereign bonds depend on the current exchange rate as well as the overall economy.

3. Municipal Bonds

Municipal bonds (often known as munis) are issued by state and local governments to fund the construction of necessary public projects like schools, housing, highways and sewer systems. The two types of municipal bonds are general obligation bonds and revenue bonds.

Usually, these bonds are exempt from federal income tax, meaning the bond investor gets a tax advantage out of each interest payment. If you live in the jurisdiction where your bond is issued, it may also be exempt from state and local taxes. The bond may be subject to federal, state and local alternative minimum tax.

Municipal bonds come with some risk because local governments are more likely to declare bankruptcy than the federal government. Their face value may be appealing, but there’s a history of small municipalities going under, taking every savings bond with them.

4. Corporate Bonds

Corporate bonds are issued by corporations to fund a large capital investment or a business expansion, differing from corporate bonds in their sourcing but not their intent. The risk depends on the reputation and financial outlook of the issuing company.

These bonds generally come with higher risk but offer higher reward. In some cases, you may see a convertible bond. This is a corporate bond that may be able to be converted into company stock. A debt security in a company with a high upside is enticing but remember that your bond portfolio must remain diverse if you want to protect yourself.

Where to Buy and Sell Bonds

Bonds are a popular choice for fixed-income investment. It is important to know where to buy and sell them to maximize returns and manage risk. You can acquire bonds through brokerage firms, banks, and online trading platforms. Each option has unique benefits and accessibility. The secondary market allows investors to sell their bonds, providing liquidity and potential for profit or loss. Whether you're experienced or just starting, knowing where to trade bonds is key to improving your investment strategy and reaching your financial goals.

Directly from U.S. Government

Purchasing government bonds directly from the U.S. government through the Treasury Direct website offers several notable benefits, primarily the absence of broker fees. By buying bonds directly, investors can maximize their returns without incurring additional costs associated with intermediaries.

The bond term is crucial when considering interest rates; generally, longer-term bonds tend to offer higher rates due to increased interest rate risk. This means that while they can provide better income potential, they also come with the risk that the market value may fluctuate more significantly over time.

Acquiring these bonds directly is a straightforward process. Investors can easily set up an account on Treasury Direct and begin purchasing bonds with just a few clicks, making it a more cost-effective investment option. By eliminating broker fees and understanding the impact of bond terms on interest rates, investors can enhance their portfolio while keeping costs down. Visiting the Treasury Direct website is the first step towards securing reliable government bonds directly from the U.S. government.

Working with a Brokerage Firm

Investing in bonds through a brokerage firm is a popular choice that provides flexibility and access to a diverse selection of bond products beyond just U.S. Treasury securities. When choosing a brokerage, you can opt for specialized bond brokers, who concentrate solely on bonds and offer personalized advice to aid in complex choices like bond selection, maturity dates, and interest rate effects—making them especially useful for beginners or those pursuing specific strategies—or you can select online brokerages, which are favored by many investors for their convenience and ease of use. Online platforms enable you to research, buy, and sell a variety of bonds from home, often providing tools for market trend analysis, educational resources, and simplified trade execution, making them ideal for those who prefer a more hands-on approach to investment management.

If you work with a broker, you’ll receive information regarding the bond. Go in with an understanding of common terms to help you make a smart trade. Here’s a quick look at some of the basics:

If you work with a broker, you’ll receive information regarding the bond. Go in with an understanding of common terms to help you make a smart trade. Here’s a quick look at some of the basics:

Bond Issuer: Government entity or corporation that issues the bond.

Price: Dollar amount at which the bond was last traded. This is often presented to you as a percentage of the bond’s par value — the price at which the bond was issued.

Coupon: Bond’s payment.

Yield: Coupon divided by the bond’s price. Look at the yield curve to figure out what return you can expect from your investment.

Duration or Maturity: Set number of years until your bond is fully paid and stops accruing interest.

Yield to Maturity: Yield you can expect if you hold your bond to maturity.

Bond rating: Provided by private rating services, these letter grades indicate the credit quality of the bond.

Best Bond Brokers

Ready to get serious about bonds? From the bond’s market value to a range of Treasury securities, you want investment options and a broker that support your goals. See Benzinga’s top picks for the best bond brokers.

• Best for Most Available Bonds: Interactive Brokers
• Best for Trading Ideas: Public.com
• Best for Futures Trading: TradeStation
• Best for Retirement Savers: Charles Schwab
• Best for Mobile Traders: E*TRADE

Best for Most Available Bonds: Interactive Brokers

Interactive Brokers is a comprehensive trading platform that gives you access to a massive range of securities at affordable prices. You can buy assets from all around the world from the comfort of your home or office with access to over 150 global markets.

Options, futures, forex and fund trading are also available, and most traders won’t pay a commission on any purchase or sale. IBKR is geared primarily toward experienced traders and investors, but with the availability of free trades with IBKR Lite, casual traders can also benefit from IBKR’s offerings.

With 41,000+ corporate bonds, 1,000,000+ municipal securities and 20,000+ CDs available through Interactive Brokers, the brokerage is one of the best in the industry for fixed-income securities. Interactive Brokers offers a comprehensive bond screening tool that allows you to browse by industry, yield, ratings and country.

Best for Trading Ideas: Public.com

Public.com makes it possible for you to diversify your investments to a great extent, including stocks, ETFs, crypto and alternative assets. This means that you can buy into art, collectibles and much more in the Public.com app. You can also invest in bonds with access to:

• Corporate bonds
• Treasury bonds
• Municipal bonds

You can use Public.com to learn more about bonds, get your questions answered and study the whole bond market using the app or website. There’s even a section that explains the tax advantages of investing in bonds so that you can make wise choices for the present and plan for future income.

Best for Futures Trading: TradeStation

TradeStation is an online brokerage that offers a wide variety of investment products, including bonds. You can trade government, corporate and municipal bonds for a commission of $14.95 plus an additional $5 per bond.

It recommends bond trading to diversify your portfolio and manage the effects of swings during volatile markets. It also promotes the use of bond trading as a way to earn regular income.

Best for Retirement Savers: Charles Schwab

Charles Schwab offers a variety of fixed-income securities. It has competitive pricing with a $1 bond transaction fee on secondary bond trades through its online platform. The company provides more than 40,000 offerings, some of which are commission-free.

It also offers tools such as ready-made bond ladders or a program to help you create your own. You can set bond alerts to stay updated on new offerings, ratings and status changes. If you want help with your investment strategy, get a personalized portfolio review from one of Charles Schwab’s fixed-income specialists.

Best for Mobile Traders: E*TRADE

E*TRADE offers access to more than 50,000 offerings from over 200 leading liquidity providers. It charges no commissions on U.S. Treasury and new issue bond trades. For other bonds, E*TRADE charges a $1 commission per bond. The online secondary market requires a $10 minimum and $250 maximum commission charge.

E*TRADE offers easy-to-use bond tools and the support of its fixed-income specialists. When you open an account, you’ll receive access to its comprehensive bond resource center. You can quickly find bonds that match your investment objectives by using its basic and advanced screeners. You’ll also have access to the latest bond yields and market tools.

Like Charles Schwab, E*TRADE offers a bond ladder builder to help you manage risk.

Why Should You Trade Bonds?

Investing in bonds can help individuals diversify their portfolios and manage risk. Bonds are loans from investors to borrowers, usually corporations or governments. In return, investors receive regular interest payments and get back their principal at maturity. Bonds are relatively stable compared to stocks and provide predictable income. They may also offer tax benefits. As interest rates and economic conditions change, it’s important to understand bond trading. This knowledge can benefit both experienced investors and beginners. The next sections will highlight key reasons to consider trading bonds for your investment strategy.

Stability and Safety

Bonds are considered safer investments than stocks. They provide fixed income through regular interest payments, known as coupons, over their term. When a bond matures, you receive your principal amount back. This predictability creates a stable source of income. It makes bonds a reliable choice, especially during volatile market periods. Bonds are usually less affected by market fluctuations than stocks. As a result, they help reduce overall portfolio risk. This can offer peace of mind for investors who focus on preserving capital.

Diversification

Incorporating bonds into your investment portfolio can help with diversification. Diversification means spreading investments across different asset classes. This approach reduces the risk linked to any single investment. Bonds usually have a low correlation with equities. This means they can perform differently during various market conditions. For example, when stock markets decline, bonds may hold their value or even increase. They can act as a buffer during economic downturns. By diversifying with bonds, investors can improve the resilience of their portfolios. This strategy can mitigate the negative impact of stock market volatility.

Income Generation

Bonds attract income-seeking investors because of their regular interest payments. These payments offer a steady cash flow. This can be beneficial for retirees or those wanting to add to their income. Unlike stock dividends, which can vary based on company performance, bond interest payments are typically fixed and predictable. This consistent income can help cover living expenses. Therefore, bonds are an important part of a balanced investment strategy for financial stability.

Considerations Before Trading Bonds

Before you start bond trading, it's important to understand several key factors. Bonds are often viewed as safer than stocks, but they have their own risks and rewards. Interest rates, credit ratings, tax implications, and economic indicators can all affect bond prices and yields. You should also consider market conditions and the issuer's financial health. Personal investment goals are important too. This overview will help you understand what to consider in bond trading, so you can make informed decisions with more confidence.

Interest Rate Risk

One significant risk of bond investing is interest rate risk. Bond prices move in the opposite direction of interest rates. When rates rise, bond prices usually decline. This can lead to capital losses for investors who sell their bonds before maturity. Bond investors must understand the current interest rate environment and possible future movements. For instance, if the Federal Reserve indicates an increase in rates, existing bonds may decrease in value. This happens as new bonds are issued at higher rates. Therefore, it is important to monitor economic indicators, central bank policies, and market sentiment. This helps anticipate interest rate trends and adjust bond investment strategies appropriately.

Credit Risk

Credit risk, also known as default risk, is the chance that a bond issuer cannot meet payment obligations. This includes both interest payments and returning the principal at maturity. It is important to assess the creditworthiness of the issuer before investing in bonds. Issuers can be government entities or corporations. Credit ratings from agencies like Moody's, S&P, and Fitch provide insights into an issuer's financial health. Generally, bonds rated AA or higher are considered safer investments, but they often come with lower yields. On the other hand, lower-rated bonds may offer higher yields, reflecting the higher risk of default. Investors should evaluate their risk tolerance and investment goals to choose bonds that fit their overall strategy.

Liquidity

Liquidity is an important factor when trading bonds. It represents how easily a bond can be bought or sold in the market without affecting its price. Some bonds, especially those from smaller issuers or with lower trading volumes, may have low liquidity. This can make it difficult to sell at a desirable price. Before investing, consider the bond's trading volume, market demand, and the presence of active buyers and sellers. Bonds with low liquidity can lead to higher transaction costs and less favorable selling conditions. Understanding liquidity can help you manage your positions effectively. This ensures that your investment strategy remains flexible and responsive to market changes.

Best Bond Trading Strategies

Trading bonds can be as passive or active as you like. No matter your approach to this type of investment, here are three tiers of strategies to get you started.

Buy and Hold

If you’re looking for a passive strategy, start with buy and hold. You buy a bond and hold onto it until it reaches maturity. Holding a debt instrument until maturity can be a good way to maximize the income generated while minimizing costs.

Bond Laddering

If you want to be more active, bond laddering is a good place to begin. With this strategy, you’ll own multiple bonds with various maturities. When a shorter-term bond matures, use the proceeds to buy a longer-term bond. This process can provide an income stream while you maintain a low-cost strategy.

Swapping

This more-active approach is popular among more experienced traders. You sell a losing bond to get a tax write-off for the loss and reinvest that money in another bond. You get rid of a bond that isn’t likely to recover and buy higher-yielding ones to build a stronger bond portfolio.

Differences Between Trading Stocks and Bonds

Stocks and bonds are two of the most traded items on the market. The difference between them starts with basic definitions:

• Stocks are shares ― or equity — in a publicly-traded company.
• Bonds are a fixed-income loan to a government or corporate entity.

The two products are traded on separate markets as well. Stock markets are where investors go to trade equity securities like common stocks, options and futures. When you buy a stock, you are buying a small ownership in the company. If the company does well, the value of the shares you purchase will increase.

Of the two components in the stock market, the first is the primary market where initial public offerings (IPOs) are issued. It is facilitated by underwriters who set the initial price for the securities. Then the stocks are opened up on the secondary market, which is where most of the trading activity happens.

The bond market is where you go to trade debt securities issued by government entities or corporations. When you buy a bond, you are lending money to the issuer for a set period of time and charging interest. Bonds are often used as a way to save for long-term goals such as retirement or a child’s education.

Like the stock market, there is a primary and secondary bond market. The new securities show up for sale on the primary market — then they go to the secondary market. The secondary market is where you buy and trade bonds that are already owned.

Is Trading Bonds Right for You?

Bond trading is an investment strategy that can serve many purposes. Even the most passive investors can use bonds as a way to save for a long-term goal. And if you’re a more active investor, bonds can allow you to build and diversify your portfolio.

If you’re interested in bond trading, do your research and identify your goals. Check out a brokerage and find the right type of bond for your long-term investment.

Frequently Asked Questions